Exploring the Legality of Algorithmic Trading in India

Algorithmic trading (algo trading) has transformed the operation of financial markets all over the world and the impact of it is also evident in India. With growing use, there is a question in everybody’s mind whether algorithmic trading is legal in India. This development has sparked concerns among people about the risks involved such as market manipulation, imbalanced trade practices, and whether there is enough regulatory control or not.

This article delves into the legality of algorithmic trading in India. Before going into the details, let it be explained as to what algorithmic trading is.

Also Read | How Big Data is Revolutionizing Algorithmic Trading?

What is Algorithmic Trading And What Does That Mean?

In its Circular No. CIR/MRD/DP/09/2012, dated March 30, 2012, the Securities and Exchange Board of India (SEBI) has defined algorithmic trading as "Any order generated based on automated execution logic shall be referred to as algorithmic trading." This definition clearly highlights that algorithmic trading is based on the use of pre-programmed instructions to make trades in financial markets. It is thus the purchase and sale of financial products using computer programs under specific pre-defined rules. These algorithms automatically execute trades in a manner that maximizes efficiency, velocity, and limits market impact. Usually in fractions of a second, the algorithms analyze market data such as prices, volumes, and timing to execute trades swiftly and efficiently. It is extensively utilized by institutional investors like investment banks, stock brokers, mutual funds, and hedge funds and offers advantages of improved execution, reduced human interaction, improved risk management and servicing high volumes of trades.

Key Guidelines From Sebi Related to Algo Trading

In the beginning, SEBI felt it was necessary to create good guidelines so that algorithmic trading would mot compromise the stability of the market. The guidelines of SEBI are to avoid market manipulation, ensure transparency, and ensure the safe and efficient utilization of algorithmic systems. A regulatory framework to manage algorithmic trading in India has been designed by SEBI without jeopardizing market integrity. This is because automated trading is gaining popularity. Some key guidelines of SEBI are:

SEBI Circular No. CIR/MRD/DP/09/2012 (March 30, 2012) – Broad Guidelines on Algorithmic Trading

This circular was issued by SEBI on observing that adoption of technology for the purpose of trading in financial instruments had been on a rise over the past few years at that time.. As per SEBI, stock brokers and their clients were significantly increasing their usage of trading algorithms Accordingly, based on the recommendations of the Technical Advisory Committee and the Secondary Market Advisory Committee, SEBI decided to implement certain specific guidelines for algorithmic trading in the securities market, the key points of which are as follows:

• Definition of algorithmic trading: Orders placed using algorithms.

• Risk management: Brokers are required to install risk management systems for algorithmic trading and adopt measures to prevent market disruptions.

• Stock exchange systems: Stock exchanges must ensure their systems are robust enough to handle the stress from algorithmic trading and monitor the market for optimal performance.

SEBI Circular No. CIR/MRD/DP/16/2013 (May 21, 2013) with the Subject “Broad Guidelines on Algorithmic Trading”

Referring to its earlier Circular No. CIR/MRD/DP/09/2012 dated March 30, 2012, on 'Broad Guidelines on Algorithmic Trading,' SEBI issued this circular after receiving various suggestions concerning the system audit requirements for the trading algorithms/software used by stock brokers/trading members. Following a detailed examination of these suggestions in consultation with the Technical Advisory Committee, SEBI decided to revise the requirements.

Key Points:

• System Audit: Brokers using algorithmic trading are required to conduct a system audit every six months by qualified and certified auditors with expertise in information systems or information security management.

• Deficiency Action: Any deficiencies identified during the audit must be reported to the stock exchange and rectified immediately. Failure to comply can result in the suspension of trading software and penalties.

• Surveillance: Stock exchanges must strengthen the monitoring of algorithmic trading to detect and prevent market manipulation and disruptions.

• Penalties: Penalties for high order-to-trade ratios had been increased; repeated violations may lead to the suspension of proprietary trading rights.

SEBI Circular No. SEBI/HO/MRD/DP/CIR/P/2018/62 issued 9th April 2018 with the subject "Measures to Strengthen Algorithmic Trading and Co-location/Proximity Hosting Framework"

With a view to 

1.  address certain issues relating to algorithmic trading and the co-location/proximity hosting facilities provided by stock exchanges, and 

2. achieve a level playing field between algorithmic/co-located trading and manual trading,

a discussion paper was issued by SEBI on August 5, 2016. After considering public comments received thereto and based on the suggestions of its Technical Advisory Committee and Secondary Market Advisory Committee, SEBI took a decision to introduce certain steps relating to algorithmic trading and the co-location/proximity hosting framework provided by stock exchanges. 

Key Point:

• SEBI established policies for Managed Co-location Services and approved simulated environments for testing algorithms.

SEBI Circular No. SEBI/HO/MIRSD/MIRSD-PoD/P/CIR/2025/0000013 dated February 4, 2025, titled "Safer participation of retail investors in Algorithmic trading - to be Implemented on August 1, 2025

Taking into account the growing demand for algorithmic trading among retail investors, SEBI has issued this circular to regulate their participation in such trading activities. The circular outlines the requirements for brokers, algo providers, and exchanges, ensuring proper safeguards and transparency in the market. 

Key Points:

• This circular outlines the regulatory framework for retail investor participation in algorithmic trading.

• It introduces requirements for brokers and exchanges, including the use of Application Programming Interfaces (APIs), algorithm registration, and continuous trade monitoring to ensure market integrity.

• The circular mandates proper safeguards to protect retail investors and promote transparency within the market.

• The provisions shall come into force on August 1, 2025.

How  Can One Legally Trade Using Algorithmic Trading in India

People who want to exploit algorithmic trading opportunities need to adhere to the regulatory landscape drawn up by SEBI irrespective of their line of business or location. Guidelines are aimed at preserving market integrity, transparency, and risk control and ensuring responsible usage of algorithms.

In order to engage in algorithmic trading legally in India, all participants, including brokers, third-party algo providers, and investors, must adhere to SEBI's specific regulations. The following steps outline how trading is to be done legally using algorithmic trading:

A SEBI-Registered Broker Should Be Selected

• It should be ensured that the broker chosen is registered with SEBI and API-based trading services for algorithmic strategies are offered. Additionally, it should be confirmed that the broker has experience with handling algorithmic trading operations.

Algorithm should be Developed and Registered

• If own trading algorithm is developed, it must be registered with the relevant stock exchanges in case the specified order-per-second threshold is exceeded. This helps control excessive orders that could disrupt market conditions.

• Algorithms should focus on by developers that prioritise ethical trading practices to avoid market manipulation.

• Algorithms from third-party providers must also be ensured to comply with SEBI’s standards and to be registered with the exchange.

The Algorithm Must Be Back tested and Verified

• It must be ensured that the algorithm is properly back-tested with historical market data to verify its functionality.

• Back-testing must include testing the algorithm on different market conditions to determine its performance in different situations.

• After back-testing, the algorithm must be verified by testing it in a simulated environment to confirm that no unforeseen errors take place in live trading.

Principals Should Be Represented by Brokers

• The brokers should act in the capacity of principals while algorithmically trading so that trades executed by an algorithm fall within the purview of SEBI regulations.

• It should be ensured that there are automated systems by brokers to maintain compliance as per SEBI's requirements.

• It is the responsibility of the brokers to make sure that all algorithms being employed by investors (institutional and retail) are registered and adhere to pre-defined risk management protocols.

Unique Algo Order Identifier Must Be Conformed to

• In the Algo program, orders admitted by the broker shall be assigned a separate unique identifier so that all trades can be tracked and monitored for adherence to market regulations. Any suspicious trade may be detected and properly investigated. Regular checks should be carried out on these identifiers such that no orders have been left out by mistake.

Compliance with Risk Management has to be Followed

• It is SEBI’s instruction that every algo order is subject to computerized risk management (like price caps, quantity caps, real-time monitoring of abnormal activities, etc.). Such risk controls are to be implemented by brokers ensuring that adequate operations have been provided for.

• The parameters added in the algorithm must exist for detection of the smallest irregularity in trading patterns, in respect of preventing bigger disruptions.

Due Diligence and Monitoring Must Take Place

• Due allowance shall be shown by the brokers when bringing in third-party algo providers to make sure they comply with SEBI guidelines and have proper systems in place.

• Round-the-clock monitoring of algorithmic systems will be necessitated in order to identify malfunctioning or unusual activity, which could further impact the market. It should be ensured that third-party algo providers conduct regular self-assessments.

Conducting System Audits on the Learning

• On a routine basis, system audits shall give assurances to the algorithmic brokers that their algorithms are running per SEBI's risk management framework and under no circumstances threaten the market's stability. Audit logs should be maintained by the broker for every trade done through algorithmic trading that is subjected to subsequent audits and disputes.

The 2025 SEBI’s "Safer participation of retail investors in Algorithmic trading” Circular dated February 4, 2025 should be Followed 

• New SEBI guidelines with regard to algo trading will apply to all market participants, including retail investors. These regulations are to be implemented on August 1, 2025, and will define the role of brokers, exchanges, and algo providers in managing all types of engagement with the markets, ensuring smooth and controlled transactions. Retail investors must learn about the intricacies of algorithmic trading so that they know the effect of algorithmic trading on their investments.

Conclusion

The Securities and Exchange Board of India (SEBI) has released several circulars to control the activities and development of algorithmic trading in India. Basically, these guidelines have been to promote transparency, prevent market manipulation, and ensure market integrity. Algorithmic trading is legal in India, as long as compliance is carried out with strict regulations and guidelines laid down by the Securities and Exchange Board of India (SEBI). Institutional investors have been using algorithmic trading for a while. Recently, new guidelines for retail investors have been released, which are set to be implemented in full wef 1st August, 2025. These are designed to extend these protections to a larger market segment.

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